Design One

Title: Candidate Number: Exam Name:

Ontario 1234 SOA - 1 Examination

2010 School of Accountancy Question 2 - Suggested Solution

DESIGN ONE MEMO TO: ANDREAS L’ABBE FOR DISCUSSION WITH MELISSA CHONG

Taxation issues See Exhibit I for calculation of tax rates of a sole proprietor versus incorporation. As demonstrated by current federal and Ontario tax rates, there may be some permanent tax savings available to Melissa should she choose to incorporate her business. The assumption here is that Melissa only intends to grow her business to the point that taxable income does not exceed $450,000, thereby subjecting her only to the small business tax rate of 16.5%. Such a rate applies to active business income (ABI) for a CCPC up to $500,000. See Exhibit II for detailed calculations and explanations pertaining to the proposed rollover of assets from her current sole proprietorship to the corporation. Incorporation Tax deferral Since Melissa indicated that she already has significant income (the $130,000 annuity) outside of Design One, she could benefit from the additional flexibility in the timing of the receipt of income personally. As demonstrated in Exhibit I, under a sole proprietorship, all of the income she earned from the business would be taxed at the rate of 46% (since she would be in the highest marginal tax bracket due to the level of annuity income she is receiving). Under a corporation, however, she could choose to leave excess funds in the corporation to the extent that she does not require all of the monies immediately. Those funds would only be subject to the low rate of corporate tax (16.5%). The additional dividend tax (about 31% of actual dividend) would only apply when she withdrew the funds from the corporation. Given the time value of money, there is a significant tax deferral opportunity here. Income splitting Melissa could also achieve some income splitting benefits by making her husband a shareholder of the corporation. As a shareholder,...